Dell Does Better than Many Think -- Except in R&D

The various press summaries of Dell's performance last quarter largely focused on falling revenue and profit. But if you look at little deeper at the numbers, Dell actually didn't take a sudden dive off a cliff, and things aren't as bad as they seem on the surface in the near term. But, long term, R&D spending that is low relative to competitors could create a problem.

First stop, cash. In a bad economy, the usual CEO chant becomes "Cash is king." That's because a lack of liquidity can be a killer, because if you don't have enough money to pay the expenses you must, then you aren't going to keep your doors open.

The quarter's current ratio, or current assets divided by current liabilities, was 1.41 -- significantly higher than the 1.18 of a year ago. Net free cash flow was $708 million, a darned sight better than the -$133 million of the same period in calendar 2008. Days supply in inventory is seven, versus 9 the year before, and days sales outstanding -- a measure of how effectively the company is getting paid for purchases -- is at 34 days, a day down from last quarter and two down from the same period in 2008. And according to the income statement, cash and cash equivalents are at $9.691 billion, up 17 percent from last year at the same time. Liquidity has actually improved, which is not too shabby. Now, I do wonder whether it is coming on the backs of suppliers. I remember talking to a small Dell vendor a few years back who mentioned that the company has a clock-like but unforgiving payment cycle of four months. Even for a large company, that seems pretty high. So you have to take the ability to keep cash on hand with a grain of salt.

Next stop, which appears at first to be negative, is looking at various important numbers viewed as a percentage of net revenue.

Gross margin is down a bit, and many expense categories, including SG&A and total operating expenses, are up as a percentage. However, remember that quarterly net revenue is down over 23 percent from the previous year, and cut as you may, there is going to be a certain amount of fixed expense that stays in place for a business of this size. Those expenses will go up as a percentage of net revenue. Gross margins are around where they've been historically, so no big cause for concern there.

What should be a red flag for future competitiveness, however, is the level of R&D as a percentage of net revenue. As I've reported before, HP's R&D was about 2.5 percent of revenue last year, and that was down significantly from its previous spending. R&D spending at IBM was at a daunting 10.7 percent level.

To be fair, Dell's business model has long been to leverage design and research done by third parties, but that's simply not the same as having the intellectual capital in-house. My colleage Michael Hickins has noted that the company's R&D investment as a percentage of total spending has actually increased. I'd argue that percentage of total spending probably doesn't reflect relative value to a company as well as percentage of net revenue. In that light, even though Dell is well set for surviving the near term, it isn't investing in the innovative muscle it needs in this industry, and its more distant prospects might be a good deal dimmer.